At first glance, the fact that Britain had the third highest deficit in the
European Union last year is alarming.

Portugal is in the process of negotiating an €80bn (£71bn) bail-out, yet its 9.1pc deficit is conservative relative to the UK’s 10.4pc. Spain, another troubled nation, has a deficit of 9.2pc. Those worse off than the UK are Ireland and Greece – basketcases which have already been rescued by Brussels, the International Monetary Fund and friendly neighbours.

The deficit is only half the story, though. It has to be seen in the context of total Government debt. And there, the UK does not fare quite so badly. Eurostat uses a different method of calculation than the Government, and on that measure, the UK’s public debt as a proportion of GDP stands at 80pc. By comparison, Greece’s debts are 142.8pc of GDP, Ireland’s 96.2pc and Portugal’s 93pc. Even Germany has greater public borrowings than the UK, at 83.2pc of GDP.

It is the interplay of the deficit and public debt that defines a nation’s fiscal sustainability. The deficit is the amount the state spends over and above what it takes in tax revenues. As a result, it adds to the debt burden. A small deficit, though, is entirely sustainable. So long as the economy is growing faster than the deficit, debt as a proportion of GDP shrinks.

Imagine a household that spends more than it earns but whose assets – the home and other investments – are growing significantly faster. Total debt may rise, but will become increasing insignificant compared with the family’s net worth. On a national level, net worth is GDP, which is why economic growth is so vital to reducing the nation’s debt burden.

A large deficit, though, will almost certainly mean public debt is growing faster than the economy – particularly if the economy is in, or recovering from, a recession. Left like that, the national debt will balloon out of control.

The level of debt considered unsustainable appears to be fairly arbitrary, but credit rating agencies typically downgrade a nation when debt as a proportion of GDP breaches 100pc. The US is on a trajectory to do so this year, which is why S&P put the world’s biggest economy’s AAA-rating on “negative watch” last week.

That’s when fiscal consolidation is needed, to get the deficit back down below rate of economic growth so debt as a proportion of GDP starts shrinking.

Eurostat’s calculation of the UK’s deficit does not come as a surprise. The 10.4pc statistic is well-known and has been widely reported. Chancellor George Osborne has used the European comparison on numerous occasions to demonstrate that Britain is keeping dangerous company. It is the relatively low level of national debt and the Coalition’s firm commitment to bring the deficit down swiftly that has kept the UK out of the “bond vigilantes” sights.

The profile of a country’s financing requirements is also key. Britain has borrowed a lot of long-term money, so although it has a large amount of debt it does not need to roll much over at any one time. Last year, just 5.3pc of the UK’s stock of debt matured and needed replacing. By contrast Germany had to refinance debt equivalent to 8.5pc of GDP, and Italy 20.3pc. The outlook is much the same across Europe for both this year and next. The more a country has to raise in the markets during, or shortly after, a crisis, the riskier its debt profile becomes.

Even that’s not the whole story, though. Although the debt-deficit interplay is critical, a number of other factors feed into the state of the public finances. Weak banks are a big risk. The UK has had to borrow £124bn to inject directly into the banks – roughly equivalent to a whole year’s financing needs for the state. Ireland’s deficit rocketed 20 percentage points after it had to bail out its lenders – to 32.4pc. Questions remain about Spain’s financial institutions, but it is almost universally accepted that the UK has done all it needs to fix our lenders.

A hugely indebted corporate and household sector may also pose a problem. A high level of borrowing may slow economic growth as families and companies spend more of their money on paying off their debts than consumption and investment.